The Fragility of the Banking System: Lessons from Recent Failures

Banking Analyst’s Calm Interrupted by Regional Bank Stock Plunge

After the intense days leading up to the takeover of ailing lender First Republic by JPMorgan Chase, banking analyst Christopher McGratty was looking forward to a quieter day. However, just minutes after regular trading began, the regional bank stocks he covers began to plunge. McGratty received dozens of emails and voicemails and saw his screen turn completely red, catching him off guard. The orderly resolution of First Republic was supposed to ease concerns about the state of the banking system, not reignite them.

Wall Street Analysts Stumped by Steep Declines in Regional Banks

Following the March failure of Silicon Valley Bank, regional banks experienced a sharp selloff. However, after JPMorgan Chase took over First Republic, experts expected concerns to subside, but the steep declines resumed. PacWest shares fell 28% to a record low, while Western Alliance lost 15%, leaving banking experts searching for answers. Some suggested triggers included fears about uninsured deposits, worries about commercial real estate, and impending regulation. Others pointed to pressure from short sellers, adding to the confusion.

Emotions, Not Fundamentals Driving Mid-sized Bank Stocks

While mid-sized banks’ first-quarter results initially calmed investors’ concerns about deposit outflows, the current market is more about human emotions than banks’ evaluations. Experts worry about the danger to mid-sized banks, as pressure on bank stocks could cause customers to withdraw their deposits. Bank analysts John Pancari and Christopher McGratty believe that while they are confident in the liquidity and capital levels of the banks post 1Q, market pressures on bank stock valuations could feed a self-fulfilling prophecy.

Banks More Fragile Than Ever Before

The events of March showed that banks can fail much faster than previously expected. Deposits were withdrawn from Silicon Valley Bank, causing a customer-led run on the bank, showing how digital banking tools and social media can turbocharge the deposit flight. Christopher McGratty, head of U.S. bank research at KBW, warns that this current turmoil is more frightening than the 2008 financial crisis. Bad loans that were the root cause of previous crises can take months to bring a bank down, whereas a customer-led run on deposits can kill a bank in as little as 36 hours.

Fragility of the Banking System

The recent selloff of regional bank stocks highlights the fragility of the American banking system. The events of March showed that banks can fail faster than expected. The current market is driven by human emotions and sentiment, not fundamental evaluations. Bank analysts worry about the potential for mid-sized banks to fall, with pressure on bank stocks causing customers to withdraw their deposits. The situation feels a lot like March, and experts warn that market pressures on bank stock valuations could feed a self-fulfilling prophecy.